Diversifying Financial Portfolios to Guard Against Risk

One thing we all can agree on is that nobody likes to be in debt. The anxiety and uncertainty that debt-fueled behavior causes is simply not worth it. There are many ways to guard against debt, or at least to minimize the effects of debt. These include establishing a well thought out budget, minimizing extraneous expenses, or eliminating them entirely. Most of us are on fixed income streams, in the form of wages or a salary. While it is difficult to generate more revenue, it is certainly a lot easier to cut expenses. There are many ways to approach financial independence, not least of which is hedging against volatility in the markets.

What Does your Financial Portfolio Look Like?

Most of us who are fortunate enough will have a 401(k) plan for retirement. Some of us may even have additional money in savings accounts, fixed-interest-bearing accounts, and the like. The goal in all cases is to put away enough money for retirement so that we don’t have to worry when we get there. Is this achievable in this day and age? Certainly, but it takes some doing. Hedging against risk is the first step in the process. Traditional portfolios include a mix of domestic and foreign investments, cash and cash equivalents, high, low or medium risk assets etc. More people are turning to investments in foreign destinations as their go to hedge against domestic uncertainty. This makes sense given the state of financial markets.

There are many examples of how to use macroeconomic data to your advantage when investing abroad. Consider the following:

On June 23, 2016, Britons voted in favor of a Brexit. That fateful decision sent the GBP crashing to 31-year lows. UK traders who anticipated these market movements were quick enough to cash out of their GBP holdings and purchase foreign currencies such as USD, JPY, EUR, even ZAR. The net result of these smart decision-making processes is that traders with the right mindset could hedge against the falling pound. For everyone else, Britain became the go-to destination for investment purposes.

The Major Currencies were Extremely Volatile in 2016

Now that the pound is cheaper relative to the USD, EUR, and JPY, travel to the UK and investments in the UK are also cheaper. Provided inflation is kept in check, the UK presents itself as a profitable opportunity for foreign investment purposes. Similar market movements are possible when the Fed embarks upon an aggressive policy of interest rate hikes. The USD will strengthen after rate hikes are introduced, so foreign buyers of the USD will purchase more dollars before the rate hikes going to effect. This saves them money in the long term. Such activity in the currency trading arena is commonplace. Forex traders, casual traders, and investors routinely buy currency with the objective of hedging against geopolitical risk.

 

Let’s take a look at the currency movements in 2016 as a case in point. The GBP/USD pair had a high of 1.5023, and a low of 1.1450 – that dovetails precisely with the Brexit referendum. The average currency exchange rate for the GBP/USD pair (the cable) was 1.3457 last year. We can certainly use these trends and indicators to gauge the financial markets for clues about future direction. Another pair worth highlighting is the USD/CAD pair. The loonie is heavily influenced by commodities like crude oil. In 2016, the USD/CAD pair had a high of 1.4691, and a low of 1.2458. The year average was 1.3254. While these movements may not appear to be too dramatic, they certainly are. Consider that if you had $1 million, you would get C$1,469,100 on the high-end or $1,245,800 on the low end. That’s a difference of over $224,000. As you can tell, there is certainly merit in the hedging against risk by switching to a different currency or investing abroad.

 

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